from First Quarter 2010
Corporate Board Member
by Sharon Kahn
Boards continue to expose their companies to a possible credit-rating hit, accepting it as part of the price of setting new strategy. “It’s a balancing act,” says Diane Vazza, managing director and head of global fixed-income research at Standard & Poor’s, citing as an example a company’s taking on debt to make a strategic acquisition. “Some companies think they can be more effective at a BBB level than an A level.”
Most of the 1,167 downgrades reported by S&P through the first nine months of 2009 were involuntary, of course—including General Electric’s, which lost its triple-A rating—and the total represented a big increase over the 585 downgrades in the same nine months of 2008. But for a decade or so, whole groups of companies have chosen to let their debt levels rise, knowing that their ratings would most likely fall. That has certainly been true of the triple-A club, which in the early 1980s included more than 60 nonfinancial U.S. companies. Membership is now down to four: Automatic Data Processing, Exxon Mobil, Johnson & Johnson, and Microsoft.
According to Mark Gray, a group managing director at Moody’s Corp., one of the three best-known ratings agencies, most of the former triple-A companies could reclaim the elite rating if they wanted to. “They’re good companies with enough cash flow to pay off debts and maintain their ratings if they so choose,” he says. “Instead, they opt to increase their leverage to take advantage of opportunities.”
Companies in the lower ratings tiers have also taken hits that pushed them into the so-called speculative or non-investment-grade range of BB+ or lower. As a result, “about two-thirds of nonfinancial U.S. companies have speculative ratings,” says S&P’s Diane Vazza. “In 2001 about half of them were speculative-grade; in 1980 only one-quarter were.” Again, these groups included companies that were unable to influence their ratings, as well as those that saw their ratings drop because of new strategies they’d set.
The wider availability of capital over the last decade or so is one big reason so many directors are accepting credit downgrades. The typical 15- to 30-basis-point differential in what banks charge for loans to a triple-A versus a double-A company is not as significant as it used to be. For one thing, the advent of structured finance has allowed many companies to lower their cost of borrowing through such methods as selling receivables off the balance sheet. Even more compelling, the pool of investors willing to tackle greater risk has gotten broader and deeper as asset managers who were once required to stay within the investment-grade range increasingly dip lower in the search for better returns.
Continued...